Network Effects with Cryptocurrencies
As many of you know by now, Bitcoin has emerged as one of the world’s most widely used decentralized cryptocurrency. A decentralized cryptocurrency is a type of encrypted digital payment system in which users can exchange this virtual currency directly. The use of Bitcoin and similar cryptocurrencies have increased rapidly over the past few years, and with that the market price of the currency has grown exponentially. Bitcoins are bought, invested, and sold using real currency, similar to stocks, however they can also be exchanged for products, especially on the non-traceable “dark net”.
The article from the American Institute for Economic Research (AIER) raises the question: will network effects lead Bitcoin to become the most widely used cryptocurrency, or will another type, such as Litecoin and Ethereum, take the cake? As Bitcoin grows in popularity, so does its value, which would cause more people to adopt the cryptocurrency. However in the network of users and investors, multiple cryptocurrencies exist, gaining popularity and spreading throughout the network.
As we learned in class, a new product diffuses throughout a network once the proportion of a node’s links using the product surpasses a certain threshold, depending on the payoff associated with said product. However, a new product does not always diffuse throughout an entire network, it often times gets “stuck” if the density of a cluster is too high. In these examples, we have analyzed the use of a single product at a time, replacing an old product as it spreads. The AIER article calls this “lock-in”, meaning consumers typically stick with a product for a period of time before switching to a new one. But what happens when multiple products is able to be adopted by a single user? In the world of cryptocurrencies, different types have different values and attributes, so one does not necessarily need to “take the cake”. This is unlike real currency that holds the same value everywhere in the world; it would not be illogical if a user could invest their money in multiple types of cryptocurrencies and see those currencies accepted by the same businesses. So, as cryptocurrencies spread via network effects, they do not necessarily need to “replace” another product but can definitely coexist among various types.
Source: https://www.aier.org/blog/how-important-are-bitcoin%E2%80%99s-network-effects